Cchief executives of the world’s largest companies left Davos on January 20 after a week of cheering in good spirits. The mood at the annual gabfest was, if not upbeat, then at least no longer gloomy. Behind closed doors, CEOhe acknowledged that while the war in Ukraine remains a humanitarian tragedy, the risks to the world economy appear to be contained for now. Central banks have taken inflation seriously. If there is a recession in America and Europe, it should be manageable. The Chinese delegation sent the clearest signal in years that China is not only reopening after its harsh “zero covid” regime, but also reintegrating into the world. Globalization may not be at its worst, but the news of its demise seemed, to snow-swept bosses, exaggerated.
Back on earth, things look worse. “Earnings season will be a confessional event,” says Jim Tierney of AllianceBernstein, an investment firm, referring to the month or so when most companies release their quarterly results. Profits at the US banking giants, which kicked things off in the past week, fell 20% year-on-year. Investment bankers were hit particularly hard as deal-making collapsed due to economic uncertainty. At the beginning of January, Goldman Sachs laid off about 3,200 of its workers.
Profit estimates for major US companies are falling steeper than a black ski slope. In the last three months of 2022, analysts have revised their fourth-quarter earnings forecasts to WITHandP The 500 fell 6.5%, double the typical downward revision. Wall Street’s collective wisdom about the past quarter now points to a year-over-year decline in profits, the first since the depths of the pandemic in 2020 (see chart 1).
For many companies, costs are growing faster than sales. Businesses are finding that resisting wage increases is more difficult than persuading customers to bear rising costs. That will squeeze margins at a rate that analysts have yet to fully digest, as they collectively still forecast earnings to rise in 2023. If the U.S. economy slips into recession, as many economists expect, earnings will almost certainly continue to slide. Since World War II, earnings per share have fallen an average of 13% around periods of economic contraction, Goldman Sachs calculates.
The first thing companies will recognize is consumer fatigue. In the company’s conference calls with analysts late last year, many spoke of weak demand, as buyers reined in spending on discretionary items. Procter & Gamble, whose products range from diapers and detergents to dental floss, reported a drop in sales volume at its business in the fourth quarter. It only managed to meet earnings expectations because it raised prices by 10%—and plans to raise further in February.
Still, the chorus of bosses touting such “pricing power,” last year’s favorite boast, will be quieter this earnings season. Although households are still spending excess savings accumulated during the pandemic, they are increasingly hunting for bargains. US consumers cut back on everything from restaurants to electronics in December, causing retail sales to fall 1.1% on a seasonally adjusted basis compared to the previous month. Constellation Brands, which makes and distributes Corona beer to American drinkers, announced on January 5 that it plans to raise prices more slowly this year. Many retailers mark down merchandise to clear inventory. The prices of Tesla cars are globally lower by as much as 20 percent.
As demand wanes, companies take on excess costs—their second accolade. Technology companies, whose appetites for their products slowed last year compared to previous peaks caused by the pandemic, are doing so with particular fervor. Apple’s boss, Tim Cook, will cut his salary by 40% this year. Twitter is auctioning off its neon bird wall art. Less symbolically, Microsoft announced plans to lay off 10,000 people on January 18. Two days later Alphabet, Google’s corporate parent, said it would lay off 12,000. The cuts don’t fully reverse the pandemic’s tech hiring spree, but a Silicon Valley venture capitalist thinks they’ll provide “air cover” for more tech companies to lower their wages and bolster their cash flows.
The third recognition of the companies refers to the fate of the profits that will be realized. This earnings season is also the time for companies to outline their spending plans for the coming year. Overall, large U.S. companies tend to split their spending evenly between shareholder payouts (through dividends and share buybacks) and investments (research and development, capital expenditures, and mergers and acquisitions).
In the era of cheap money, before central banks started raising interest rates to quell inflation, payments were often financed with debt. Now that money is expensive, such borrowing is likely to subside. On the deal-making side, a host of acquirers are still sorting through the mess created by transactions struck at record prices during the pandemic merger boom. Write-offs that recognize a decline in value for some of them are more likely than announcements of filled war chests and the desire to conclude new deals.
That leaves investments. The mega-trends of the 21st century – decarbonisation, digitalisation and the separation of China and the West – speak in favor of huge spending on climate-friendly technology, robots and software and non-Chinese factories. One European industry chief argues that, as a result, capital spending should weather the coming downturn better than usual.
Could be. But for now, most companies are cautious. After capital spending by U.S. companies rose in the third quarter of 2022, a tracker of corporate spending plans compiled by Goldman Sachs points to continued growth, but at a much slower pace.
Many companies are likely to delay major spending decisions until economic uncertainty recedes. Ericsson, the Swedish telecommunications equipment maker, has warned that its American customers are increasingly delaying new network investments. Dell shipped almost 40% less PCs, which mainly sells to legal entities, in the fourth quarter, compared to the year before, according to IDC, a research firm. Logitech, which makes keyboards, webcams and other desktop-related hardware, now expects revenue to fall as much as 15% in the fiscal year ending in March, down from a previous estimate of no more than 8%. Software makers, such as Microsoft, and chip makers, such as Intel, could also be affected by limited digitization budgets.
Like all earnings seasons, this one will bring positive surprises. A few have already sprouted. United Airlines has increased its prices without delaying tourists and business travelers. Netflix beat expectations by adding 7.7 million new subscribers in the fourth quarter, thanks in part to a new, cheaper ad-free service. The beleaguered streaming service, which has lost roughly half of its market value since its peak in the fall of 2021, posted big profit forecasts for 2023. On January 19, Reed Hastings stepped down as Netflix co-founderCEOperhaps because he believes the worst is over for the company he founded 25 years ago.
Such impudence will be the exception rather than the rule this year. Overall, positive earnings surprises have become less positive in recent quarters (see Chart 2). Hitting an all-time high as a percentage GDP last year, corporate profit after tax seems overdue for a correction. And maybe it will fall more. High debt and low taxes, which for decades drove corporate profitability, are no longer the tailwinds they once were, as interest rates rise and appetite for deficit-financed tax cuts wanes. Real corporate life takes place at levels less diluted than the Swiss Alps. ■